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This section would make two changes in the estate tax law relating to employee plans, one of which would have general application to all employee plans.

Prior to enactment of the Tax Reform Act of 1976, any distribution from a qualified pension, profit-sharing, or stock bonus plan was excludible from a decedent's gross estate, except to the extent the distribution was attributable to the decedent's own contributions to the plan. The Tax Reform Act amended section 2039)(c) of the Code to preclude this favorable treatinent for any distribution from a qualified plan which constitutes a lump sum distribution. If a distribution constitutes a lump sum distribution, the recipient can, in many cases, elect favor alle income tax treatment of the distribution. It is not clear whether the 1976 Act precludes the exclusion for all lump-sum distributions or only if the favorable income tax treatment is elected. The bill would clarify this by allowing the exclusion if the recipient does not elect the favorable income tax treatment.

The estate tax exclusion is arguably justifiable where benefits under a qualified plan are paid in an annuity. The annuity might be paid over many years, whereas any estate tax liability attributable to it would be payable soon after the decedent's death and could far exceed the annuity amounts payable up to the time of paying the tax. This liquidity problem does not occur in the case of a lump sum distribution. If the distribution is made in a lump sum, the funds necessary to pay the estate tax are available from the distribution, whether or not favorable income tax treatment is elected or available. There is no sound basis for conditioning an estate tax exclusion upon the presence or absence of favorable income tax treatment. Therefore, if legislation is to be enacted to clarify the law, we would favor denying the estate exclusion to all lump-sum distribution.

In general, the estate tax exclusion applies to distributions from qualified plans. The second change proposed in this section of the bill would extend this treatment to ESOPs whic hare not qualified plans. Investment tax credit ESOPs and ESOPs described in the bill are not required to be qualified plans. However, an ESOP is required to be nondiscriminatory (regarding both participation and contributions) and to satisfy the contribution limitations applicable to qualified plans. Since an ESOP must meet these rules, we do not believe there is good reason to excuse the plan from meeting the balance of the qualification requirements. Hence, we would favor a requirement that all ESOPs be qualified plans. This, in turn, would make the proposed estate tax exclusion for nonqualified ESOPs moot. Section 3

Under current law, an individual who is not a participant in a qualified plan maintained by his or her employer may generally make deductible contributions to an individual retirement account (IRA) to the extent of the lesser of $1,300 or 15 percent of compensation for the year. No deductible IRA contribution is allowed if the individual participates to any extent in an employer-maintained plan during the taxable year. This has resulted in problems where employer contributions to a qualified plan are insufficient to provide true retirement security or the employee changes jobs frequently so that a retirement benefit never becomes vested.

Section 3 of the bill provides that active participation in an ESOP will be disregarded in determining whether an individual may make a deductible IRA contribution for a year. We believe this is undesirable. The intent of the Congress in enacting the IRA legislation was to make tax-favored retirement savings available to individuals who do not have this benefit through their employer. Under the bill, if an employer maintains no qualified plan other than an ESOP, an individual could make full deductible IRA contributions for a year even though an employer might make fully vested contributions on that employee's behalf to the ESOP in excess of $1.500. Our studies indicate that IRAs are largely utilized under the current rules by high income individuals and are, thus, inherently discriminatory. This provision of the bill would exacerbate that problem. since the tendency would be for highly-paid employees to utilize the available IRA deduction while receiving proportionately large contributions to the ESOP.

There are other, broad-based approaches to the IRA problem being developed in the Congress. One example is Senator Bentsen's simplified retirement plan bill. S. 3140. We believe these approaches offer a better overall solution to the problem.

Section 4

Under current rules for tax-free rollovers of lump-sum distributions from qualified plans to IRAs, the entire amount received in a distribution (except the amount attributable to an employee's own contributions) must be rolled over to the IRA. If property other than cash is received as part of the distribution, that same property must be rolled over to the IRA. The requirement that the same property be rolled over has caused difficulty, since some IRA sponsors are unwilling to accept stock, particularly stock of a closely-held corporation. This section of the bill would resolve that problem by allowing the recipient of employer securities (common stock or convertible securities issued by the individual's employer) to sell the securities after receipt from a qualified plan and deposit the proceeds of the sale with the IRA sponsor as part of the rollover contribution. Although the provision applies only to employer stock, it is not limited to distributions from ESOPs.

This type of solution to the problem is not unacceptable; since a rollover contribution must be made within 60 days after the distribution from the qualified plan, there is not a significant possibility of abuse. However, if this type of approach is used, it should not be limited to employer securities, since the same problem arises with in-kind distributions of other property. Therefore, we believe consideration should be given to applying this rule to all such distributions. If there is to be no recognition, special rules would be needed to exclude the gain from gross income. Section 6

If a lump-sum distribution from a qualified plan includes securities of the employer corporation, the Code presently provides that net unrealized appreciation attributable to the employer's securities is not included in gross income. Therefore, the net unrealized appreciation is not taxed until the securities are sold, but the currently taxable portion of the lump sum distribution is granted the special 10-year averaging device allowable for certain lump sum distributions if otherwise applicable. This extremely favorable treatment may be somewhat mitigated by the fact that long-term capital gain resulting from the ultimate disposition of the distributed shares would be treated as an item of tax preference.

Section 6 of the bill would allow the recipient of the distribution to elect to have the amount of net unrealized appreciation included in gross income. This would result in the amount of the net unrealized appreciation being subject to the 10-year averaging device and would insulate the distribution from treatment as an item of tax preference. We believe that, in the absence of a tax-free rollorer, net unrealized appreciation should be currently taxed in the same manner as any other type of lump sum distribution. No significant policy ob. jective is achieved by singling out employer stock for this special treatment. However, we find the type of taxpayer option which would result from the bill even more objectionable. Therefore, we would prefer no change rather than the change proposed in the bill. Section

Section 7 of the bill would allow a deduction for the employer for dividends paid on employer securities held by the ESOP if the dividends are distributed to participants in the plan. This is a limited form of integration of the corporate and individual income taxes, resulting in taxation of corporate income at only one level. Integration of the corporate and individual income taxes is a problem of extreme complexity which both we and the Congress have begun to examine on an overall basis. We believe the question should be addressed in terms of an overall integration mechanism and should not be limited to a single situation such as stock held by a particular form of employee benefit plan.

Section 7 would also allow a charitable deduction for income, estate, and gift tax purposes for contributions of employer securities or other property to an ESOP. Contributions by an employer to an ESOP, as well as any other type of retirement plan, are forms of compensation. Subject to the special rules for contributions to retirement plans, they should continue to be treated for tax purposes as compensation. Contributions to a plan by a person other than the employer are, in substance, a contribution to capital of the employer rather than charitable contributions in any traditional sense. Therefore, "gifts” to such an entity should not be treated as charitable gifts. Rather, to the extent that they are actually inade, they should be treated as noncharitable transfers.

Scction 8

Under current law, a corporation is liable for minimum tax equal to 15 percent of the amount by which the sum of the items of tax preference for the taxable year exceeds the regular tax (or, if greater, $10,000). The regular tax deduction in the case of a corporation is generally the income tax for the taxable year, reduced by certain credits, including the investment tax credit determined under section 38. Under section 8 of the bill, the regular tax deduction would not be reduced by the amount of the credit allowed for contributions to the new type of ESOP proposed by the bill. Moreover, for prior years, it would not be reduced by the amount of the investment tax credit attributable to employer contributions to TRASOPS.

The payment of deductible compensation by an employer reduces the regular tax deduction for minimum tax purposes. This principle applies both to ordinary types of cash compensation and deductible contributions to qualified retirement plans. A contribution to any type of ESOP is nothing more than compensation in the form of a contribution to a retirement plan. Therefore, it should not be treated any more favorably for this purpose than any other types of compensation.



Washington, D.C., July 25, 1978.
Assistant Secretary of the Treasury for Tao Policy,
Department of the Treasury,
Washington, D.C.

DEAR MR. LUBICK: At the Senate Finance Committee hearings on employee stock ownership plans (ESOP) which were held on July 19 and July 20, there were some additional questions which I wished to ask of you but which I chose to defer due to the shortage of time and the number of witnesses whose testimony we wanted to receive on those days. However, I feel that these questions, and your answers, bear directly upon the concept and therefore I request your response to these questions in time for inclusion in the hearing record. For your information, the deadline for receipt of all testimony and information for inclusion in the hearing record is August 15.

During your testimony, Senator Gravel raised the question of the timing for the promulgation of the Internal Revenue Service regulations on ESOPs which are created under the Tax Reduction Act of 1975 (TRASOPs). Senator Gravel pointed out that the TRASOPs had been in existence for almost three years and yet the Treasury Department has not promulgated regulations which can guide employers who adopted TRASOPs to date. This is extremely critical because there are well over 1,000 corporations which have taken advantage of the provisions of the Tax Reduction Act of 1975 and adopted TRASOPs for the benefit of the corporations and their employees. In response to Senator Gravel's question regarding the timing of the promulgation of these regulations, you advised him that they would be finalized soon. I feel that a more definitive answer is necessary. Please advise me regarding the actual status of these regulations and give me a target date for the finalization and promulgation of these regulations.

Perhaps an even more important question is the status of the IRS regulations regarding the matching employee contributions for TRASOPs. This is an area in which most employers have been operating in a complete statutory vacuum because the provisions of the Tax Reform Act of 1976 were necessarily vague in this regard and Treasury has completely failed to offer anny guidance. We have received numerous letters from some of the major corporations in the United States, complaining that they are unsure as to the procedures which should be followed in implementing such a program. I feel that some action by the Treas. ury Department to clear up this confusion is an absolute necessity. Therefore, I wish to be advised as to the exact status of these regulations and to be given a target date for their finalization and promulgation. In both cases, I feel that an answer that they will be forthcoming “soon" is unsatisfactory.

Approximately three months ago, we met in my office to discuss the possible resolution of a problem which exists regarding the Internal Rerenue Service reg. ulations on “put options" for stock distributed from ESOP. At that time, you discussed the matter in great detail with a member of my staff and a member of

the Senate Committee on Finance staff. During the course of this discussion, you suggested that perhaps the way in which the problem could be resolved is to permit a cash distribution from an ESOP/profit sharing plan rather than a distribution of stock, recognizing that such a distribution would relieve the necessity of giving a put option. In the drafting of S. 3241, the “Expanded Employee Stock Ownership Act of 1978”, we considered your suggestion. One of the provisions of this Act provides that an ESOP may give the election to a participant to receive a distribution of cash or stock as his benefit; in the event that the ESOP gives such an election, it will not be required to give a put option to any participant who receives a distribution of stock from the ESOP. We went on to provide that the giving of such an election does not constitute the offering of a security from the ESOP for purposes of Federal or State securities laws. In your testimory, you specifically criticized this provision in the bill. My question for you, in light of our conversations of three months ago, during which you assured me personally that you would cooperate with the Congress in resolving problems such as this, is why your office has been absolutely no help in solving this problem and why you chose instead to criticize a valid attempt made by my office to find an equitable solution to the problem. Please advise me regarding what steps you office has taken to work out a solution to this problem, documenting it with regard to any communications from your office to either my office or to the office of the Committee on Finance and advise me regarding a target date when your office will have a concrete proposal ready for this solution to the "put option" problem created by the regulations.

As stated above, I feel that a response to these questions is imperative and should be included in the hearing record. For that reason, I would appreciate having your office expedite the answers to these questions and supplying them to me at your earliest convenience. With every good wish, I am Sincerely,


Washington, D.C., August 11, 1978. Hon. RUSSELL B. LONG, Chairman, Finance Committee, U.S. Senate, Washington, D.C.

DEAR MR. CHAIRMAN: This is in response to your letter of July 25, 1978, requesting additional information relating to employee stock ownership plans to be included in the record of the hearings which were held by the Finance Committee on July 19 and 20.

As you know, the Tax Reform Act of 1976 substantially changed the existing rules governing leveraging ESOPs and 1% investment credit ESOPs established under the Tax Reduction Act of 1975 (TRASOPs). It also added a new provision for an additional one-half percent credit if matched by employees contributions. These provisions, of course, call for new regulations and in addition made our proposed regulations which were issued in 1976 inconsistent with the law in many respects. As a result of these changes, we developed a plan for the promulgation of ESOP regulations which we are in the process of carrying out. The plan called for completion of the leveraging ESOP regulations (accomplished in August 1977) followed by work in stages on the TRASOP regulations.

The first installment of TRASOP regulations will cover all the TRASOP rules including the TRASOP changes made in 1976 Act, other than rules relating specifically to the one-half percent TRASOP credit. The published documents will integrate final regulations for 1-percent TRASOPS, reflecting public comments on the original proposed regulations, with simultaneously proposed and temporary regulations, reflecting changes made by the 1976 Act. The combination of final and temporary regulations will allow the public to have a full set of binding regulations relating to 1-percent TRASOPs.

We are very close to agreement with the Internal Revenue Service on the rules to be contained in these regulations. Therefore, we expect the final documents to begin the process of formal approval at the Service within no more than 3 weeks. We and the Service will make every effort to see that the approval process proceeds smoothly and speedily.

With respect to regulations promulgating the one-half percent TRASOP rules, we and the interested offices at the Service are currently reviewing a draft of proposed regulations. These regulations contain a number of difficult problems which we will need a little more time to resolve. We expect the final document to begin the formal approval process at the Service within eight weeks. Once again, every step will be taken to assure smooth and speedy approval of the proposed regulations.

Your letter refers to another regulation project which will make technical changes in the regulations covering leveraging ESOPs. The most significant of these problems involves the requirement of the regulations that stock of a ciosely held corporation distributed by an ESOP must be subject to a put option to the employer. Some corporations, such as certain banks, are unable to comply with this requirement, because applicable state law precludes the type of stock redemption contemplated in the regulations. The problem arises initially because the Internal Revenue Code requires that an ESOP be a stock bonus plan, at least in part. Under historic rules defining a stock bonus plan, such a plan is required to make distributions in employer stock.

We have been working on a resolution which has been communicated to a menber of the staff of the Finance Committee who judged it to be a generally satisfactory solution. This resolution involves an amendment of the existing regulations to provide that if an employer is precluded by law from redeeming stock. the put may be to the ESOP rather than to the employer. A further possible requirement is that the employer would be forced to contribute cash to the plan in the event that cash was not otherwise available to honor the puts. A draft of amendments to the regulations to accomplish this result has been prepared and is being reviewed at the Service prior to circulation among the interested agencies. At this point, we do not have assurance that the proposed solution will be acceptable to the Department of Labor.

As you indicate in your letter, one alternative solution which was considered in earlier discussions was a proceeding under the prohibited transaction provisions of ERISA and the Code for an exemption under which a profit sharing plan could function in the same manner as a leveraging ESOP. Since a profit sharing plan is not required to make distributions in employer stock, the problem of the put option could be avoided by the plan making cash distributions. This would have been limited to plans of corporations which are precluded by law from making the required redemptions. S. 3241 would generalize a similar rule, allowing an ESOP to avoid a put option requirement where it permits a participant to elect to re. ceive cash in lieu of a distribution of employer securities. The same consideration led us to question the appropriateness of these solutions in both contexts. The theory underlying ESOPs is that employees are to be made true owners of stock in their employer. That function does not seem to be served where stock subject to the ESOP rules will never get into the hands of the employees. This seems especially true in the case of a credit ESOP which enjoys significant tax benefits not available to a profit-sharing plan. We believe that the approach which we are proposing in the amendment to the regulations is consistent with the ESOP concept. In the meantime, further consideration can be given to this problem on an overall basis. Sincerely yours,

DONALD C. LUBICK, Assistant Secretary for Tax Policy.

AUGUST 24, 1978. Hon. MIKE GRAVEL, U.S. Senate, Washington, D.C.

DEAR SENATOR GRAVEL : As requested by your letter of July 25, 1978, I am writing to correct what appears to be a misinterpretation of my July 20, 1978, testimony before the Senate Finance Committee on S. 3223.

My testimony did not state or reflect a preference on the part of the Depart. ment of the Treasury for state rather than private ownership of productive assets. Insofar as your General Stock Ownership Plan ("GSOP”) proposal is concerned, my testimony considered two issues, one of which was the extent to which this proposal—which is intended to provide tax incentives to encourage acquisition by the residents of Alaska of interests in energy ventures in that statedenarts from traditional notions of sound tax policv.

The model for the GSOP proposal is the leveraged Employee Stock Ownership Plan. Such a plan combines the benefit of current deductions at the corporate level for payments to a trust through which shares are purchased for employees, with tax exemption for the trust. The corporate level deduction is permissihle because it is for a payment in the nature of compensation, traditionally deductible

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